With the longawaited IBC in place during the second year and as we, bankers, ARCs, legal and accounting professionals, above all borrowers are doing their best to understand the Code, its implementation, challenges etc. the announcement was made in the 2nd week of June by the finance minister of the possibility of forming a public sector asset reconstruction company. It’s not a unique thought, rather a dormant idea of forming a ‘bad bank’ that has been under discussion for long and with good reasons accompanied by its pitfalls. However, this time the Govt. appointed a committee to look into the proposition. A committee was formed under Sunil Mehta, non-executive chairman of Punjab National Bank (PNB), with SBI Chief Rajnish Kumar and Bank of Baroda MD, PS Jayakumar to make recommendations (in two weeks) on setting up of an Asset Reconstruction Company (ARC) or Asset Management Company (AMC) for faster resolution of stressed accounts.

“There seems to be some degree of desperation in the government’s approach to fixing India’s public sector banks in order to revive credit growth. a proposal was floated to merge four loss-making banks into one; on 8 June, stand-in Finance Minister Piyush Goyal announced the setting up of a committee to suggest a faster way forward on bad loans, including

The possibility of creating an assetreconstruction or management company (ARC/AMC). Both ideas are nonstarters at this stage in the economic and political cycle. Merging four weak banks is, as we have argued, not the right way to create one strong bank. Four drunks propping each other up cannot expect to avoid a fall. And setting up an ARC is not going to solve the problems of bad loans in the foreseeable future when a general election loom less than one year away”. (The Hindustan Times, June 11, 2018)

There are several reasons for this pessimism: One, there are already more than 10 ARCs in business, and banks are wary of giving their bad loans to them. So what purpose will the creation of one more ARC serve? Two, it is also perceived that the banks are not keen to handover the bad loans to ARCs as they have to book the losses immediately on such assignment. Three, setting up an ARC and then expecting it to effectively resolve the bad loans would be apparently much less effective than the bank chasing the bad loans all by itself. The ARC will have to have the efficiency and understanding of the loan to make recovery happen, that will be at cost of time.

Coming to the route of going for a “bad bank” to manage the humungous volume of bad loans in the industry. As per the Wikipedia, “A bad bank is a corporate structure to isolate illiquid and high-risk assets held by a bank or a financial organization, or perhaps a group of banks or financial organizations. [1] A bank may accumulate a large portfolio of debts or other financial instruments which unexpectedly increase in risk, making it difficult for the bank to raise capital. In these circumstances, the bank may wish to segregate its “good” assets from its “bad” assets through the creation of a bad bank. The goal of the segregation is to allow investors to assess the bank’s financial health with greater certainty. This also will call for specialization for managing the bad loans for maximizing the value of assets locked in while the core bank will focus on the main business of lending. So, the setting of a bad bank and getting results, as fast desired by the system in India pose numerous questions on practicability given our available banking environment, resources, and management capabilities as experienced so far.

The financial crisis of 2007–2010 resulted in bad banks being set up in several countries. For example, a bad bank was suggested as part of the Emergency Economic Stabilization Act of 2008 to help address the subprime mortgage crisis in the US. In the Republic of Ireland, a bad bank, the National Asset Management Agency was established in 2009, in response to the financial crisis in that country.

Historically, the concept is pretty old if we look at the scenario at the international level. The first bad bank, Grant Street National Bank, was created by Mellon Bank in the USA to manage $1.4 Billion of bad loans way back in 1988 (prior to our RDDB Act being in existence!). Amidst a lot of objections in granting a license to this banking entity by the Federal Reserve, this bank came in existence without any public deposits, the existing shareholders of the Mellon Bank have issued shares of this bank. The Grant Street National Bank acquired the bad loans from Mellon bank at 57% value and in 1995 this bank was dissolved after all bondholders were repaid and the shareholders had handsome returns!

Again, in 1992 there was a severe banking crisis happened in Sweden due to over speculation in properties. The Swedish authorities appointed McKinsey & Co. And two banks – Retriva and Securum. Retriva took over all the nonperforming loans from Gota Bank (SV) and Securum took over the non-performing loans from Nordbanken, with the good bank operations continuing as Nordea. The government retained a significant equity stake in Nordea. Nordea has been considered one of the strongest and best-performing banks in Europe. During the Asian Financial Crisis which emerged in Indonesia and several other countries in Asia in 1997 and 1998, the Indonesian government established the Indonesian Bank Restructuring Agency (IBRA) as an official body to oversee the asset disposals of an extensive number of distressed banks. International commentators such as Brad DeLong and Paul Krugman have suggested the Swedish bad banking model is adopted internationally. Critics of bad banks argue that the prospect that the state will take over non-performing loans encourages banks to take undue risks, which they otherwise would not, i.e. a moral hazard in risk-taking and could also be an effect of political influence in lending beyond norms or the wrong entity,etc.Another criticism is that the option of handing the loan over to the bad bank becomes essentially a subsidy on corporate bankruptcy. Thus, it can become a subsidy for banks at the expense of small businesses.

So, the point that is made is no model is good/bad per se but it depends on what the requirement calls for and how the model is applied. India is grappling for a solution of its increasing NPA problems since last 40 years say. The initial recognition of the problem can be traced with the Reserve Bank of India notifying the Health Code system in 1985 which categorized the loans in eight categories – i) satisfactory, ii) irregular, iii) sick (viable / under nursing) , iv) sick (non-viable / sticky) and so on.These norms were revised in 1990. Then came the Narasimham Committee report on Financial Reforms in 1991 which brought into the concept of classifying the loans as i) performing assets and ii) non-performing assets along with it made suggestions on income- recognition and bad loan provisioning norms besides uniform accounting practices for the banks. If we take this as the starting point of reforms in recovering bad loans, the journey can be noted and the “desperation” as mentioned earlier can be traced. The net NPAs as per RBI data in 1999-00 were 17435 crores which rose to 18518 crores in 2000-01 and further to 18990 crores in 2001-02. Whereas the Gross NPA rose to 34171

Crores in 2000-01 from 32940 crores in 1999-00. “Indian banks’ gross nonperforming assets (NPAs), or bad loans, stood at Rs 10.25 lakh crore as on 31 March 2018. On the quarter, the pile has grown by Rs 1.39 lakh crore or 16 percent from Rs 8.86 lakh crore as on 31 December 2017. This chunk now accounts for 11.8 percent of the total loans given by the banking industry. For the financial year 2018, the total bad loans of these banks rose by a whopping Rs 3.13 lakh crore.

Taking note of the alarming bad loans situation, the Narendra Modi-led government, last year, announced a Rs 2.11 lakh crore bank recapitalisation plan to pull out state-run banks from the mess. As much as 90 percent of the abovementioned sticky assets are on the books of government-owned banks” (Firstpost, July 8th, 2018). In course of these years we had RDDB Act 1993, SARFAESI Act 2002, several schemes of RBI – S4A, CDR, SDR, JLF and finally Insolvency & Bankruptcy Code in 2016. But none of these acts could check the onslaught of NPA and the PSB s mostly are bled beyond acceptable levels. In 2000-01 the total non-performing assets of the PSBs were estimated at 16% of their advances.

In comparison a “ break-up of the NPAs shows that 21 public sector banks (PSBs) saw their bad loans pile grow by Rs 1.19 lakh crore (or 15.4 percent) to Rs 8.97 lakh crore in the March 2018 quarter, compared to December 2017’s figures, while that of 18 private banks surged by Rs 19,446 crore or 17.9 percent to Rs 1.28 lakh crore in the March 2018 quarter from Rs 1.09 lakh crore in the December 2017 quarter (Firstpost, July 8th, 2018)”. Thus, going through these facts the “desperation” of the Govt. Seems stem from the very low success rate of the laws and schemes over all these years and the NPA volume is now at a point to erode the banks’ capital. And thus, another strong approach to tackle this situation is reflected in the present action by the Government.

The Committee, after due deliberations and practicable avenues besides keeping the probability of any clash with the existing laws, has recommended a five –pronged approach for faster resolution of stressed assets. It has recommended the creation of an asset management company for the resolution of stressed loans worth more than Rs.500 crore. The committee had also laid out a plan to resolve SME loans within 90 days.

The report comprises a bank-led resolution process and a five-pronged strategy to resolve stressed assets called Project Sashakt. This approach will be applicable for loans upto Rs.50 Crores to small and medium enterprises as well as mid-size assets between Rs.50-Rs.500 crores, and large assets with exposure of Rs. 500 crore and more. The idea behind Project Sashakt is to ensure the operational turnaround of the banks and stressed companies so that the asset value is retained. The resolution route is also applicable to larger assets already before the National Company Law Tribunal (NCLT) and any other asset whose resolution is still pending. The Times of India report of 3rd July,2018 noted the purpose and objectives of the Project Sashakt very appropriately: “the government and banks on …unveiled a new strategy to revive stressed assets outside the Insolvency and Bankruptcy Code (IBC), including through asset management companies (AMCs) and investment funds that are expected to help leaders generate better value, while cleaning up their books to enable further lending.”

The five-pronged resolution route involves:

Outlining an SME resolution approach – through a steering committee by banks for formulating and validating the schemes, with a provision for additional funds. The timelines for completion is planned at 90 days and the resolution will be under the control of a single bank.

Bank-led resolution approach – For loans between 50-500 Crore, with the resolution timelines of 180 days.- In order to fast track NPA resolution the committee has proposed an inter-creditor agreement (ICA) framework among the consortium lenders. The ICA framework will authorize the lead bank to implement a resolution plan in 180 days and the leader would then prepare a resolution plan including appointment of turn around specialists and other industry experts to complete the resolution plan within the RBI mandated stipulated time. The resolution plan has to be approved by lenders holding at least 66 per cent of the debt.

AMC/AIF led resolution approach- For assets over Rs.500 crore an independent Asset Management Company (AMC) will be set up. The Committee also stated an Alternative Investment Fund (AIF) which would raise funds from institutional investors. A very important element of this plan is to rope in AIFs that will provide capital structure to the ARCs and the AMC to acquire the entire loan from all banks which will be a shift from the present scenario where a handful of banks sell assets to ARCs. “The key focus of the report was on around 200 large loans of over Rs.500 Crore that were spread across multiple banks and were affected by fragmented decision making, limited capital base of ARCs and the current model of security receipts or instruments that offer payment to banks over a long period” (TOI/ 3rd July,2018). In an interview to Livemint (published on July 5, 2018) Mr. Sunil Mehta elaborated this proposed model “The moment banks sell it to asset reconstruction companies and these ARCs will in turn transfer the ownership of asset to the Alternate Investment Fund (AIF). The AIF then becomes the effective owner because the intent is that the promoter if at all he is there becomes the minority. His control goes below 24%. The new owner which is the ARC and AIF are the ones that controls the asset and hence their stake will be 76% and above. No one, even the promoter, should have blocking rights.”

NCLT/IBC approach – The resolution which do not meet the 180 days deadline will be referred to the National Company Law Tribunal for action under the IBC.

Asset-trading platform – The Committee suggested setting up of a trading platform for sale of performing as well as nonperforming assets of the banks. This is essential in organizing the strategic resolution of cases in a uniform manner which may eliminate the ad hoc approach to valuation and pricing issues involved in transfer of the assets.

The recommendations by this committee of the domain experts put to rest the creation of a bad bank and has identified two ARCs as well to facilitate the further process. However, there are certain questions that come up at the moment while we try to understand the difference this committee could make- “..most of the Mehta committee’s recommendations are largely aimed at deferring the inevitable, rather than resolving the NPA mess. For instance, for loans up to Rs 50 crore, the panel has suggested a steering committee within the bank to resolve it within 90 days. But by giving this extension for resolution, the panel has subverted the RBI’s circular of February this year that mandated the banks to report a bad loan to RBI by the 91st day and plan to take it to insolvency thereafter. Surprisingly, it has even suggested giving additional loans to revive the asset. That amounts to ever-greening, just what must be avoided for NPAs.” (Business Today, July 6,2018). With the passage of 90 days since the Project came in, there are no confirmed report in public domain as to its implementation and progress. However, the Hon’ble SC having stalled the implementation of the RBI Circular of February 12th (for referring stressed assets (Special Mention Assets) to NCLT on completion of 180 days) and allowing the deferment of certain power, sugar, textile, etc. industries from being referred to NCLT till next date of hearing on 14th November’18 can also provide fodder to the spirit behind the Project Sashakt. The effective resolution percentage of these stressed assets in between could be the parameter for the idea being acceptable or otherwise.

It appears that the provision of bank led efforts in resolving the assets in 50-500 crore category with a time line of 180 days could be an extension for a recognized NPA being referred under IBC by 6 months! So, it may be a view taken that inspite of the problem of NPA been recognized, this Project Sashakt once implemented should not appear to be a breather for the defaulting companies (as well as Banks!) from the strict and tough IBC regulations. Its success will be tested if it really makes the banks stronger.